Honor Among Thieves

When the Securities and Exchange Commission threw down the gauntlet against Goldman Sachs on Friday, Henry Kissinger’s bon mot on the brutal 1980s war between Iran and Iraq sprang to mind: “Too bad they can’t both lose.”(HT: Andrew McCarthy, NRO)

His recent, sudden and convenient discovery that Goldman Sachs has done shady deals is a precious example of why I’d prefer Barack Obama go tee off on something other than the rule of law and the discipline of the marketplace. Yes, I comprehend that Presidents with poll numbers clogging the clubhouse commode will tend to search for what John Lennon described in the psychedelic rock ode “Revolution #9” as a serviceable villain. However, something more devious motivates President Obama to return the $994K he received in campaign contributions from America’s Iniquitous Vampire Squid.

The SEC indictment of Goldman Sachs is the opening salvo in his effort to pass his version of so-called financial reform. It also reeks of something far worse. It shows a government that desires to prosecute an business that caters to the bad decisions of its customers. This would open a can of worms that could potentially make being in business within the United States of America too big of a hassle to be worth bothering with.

To whit, Goldman Sachs sold a mortgage-backed security called the ABACUS 2007 – AC1. A trader with the firm, Fabrice Tourre, offered a negative professional opinion on the value of this security. Tourre wrote an email that provides the gravamen of what the SEC has taken to the Grand Jury.

Tourre’s e-mail reads like this: “The whole building is about to collapse anytime now…Only potential survivor , the fabulous Fab…standing in the middle of all these complex, highly leveraged, exotic trades he created…” – (HT: RealclearMarkets)

According to the Feds involved, Goldman’s iniquities go far deeper than just peddling junk. One of the people advising GS on which mortgages to package in ABACUS also bet big against the security and made billions. If he wrote the logic behind the set-cover algorithm used to build the security, and then placed his shorts against the instrument, he belongs with Brutus and Cassius in the cold-storage section of Dante’s Inferno.

Yet that isn’t what the SEC has legally argued. They claim Goldman intentionally led clients to make decisions that damaged client welfare. If the government can’t make the case that GS intentionally bilked people into buying ABACUS products, it doesn’t have any rope with which to hang the Evil Banksters after their cheesy, photo-op show trial.

This brings up a problem. What if every company that ever sold the customer something that didn’t work out got hauled into the docket under precedent set in U.S v. Goldman Sachs? Or what if every customer who ever had regrets the morning after used this case as a fulcrum to bully and harass the counterparty on an unfortunate deal?

The obvious answer is that far fewer deals would get made. Companies that don’t make deals have no need to fabricate product or continue paying a workforce. Reference the unemployment rate in Detroit, MI if you don’t believe me on that.

Goldman Sachs presents a difficult test for modern governance. They bend rules. They aggressively push for advantage. They are like the professional athlete who takes advantage of the referee when given the opportunity. They may well have taken John Paulson’s advice on which mortgages to package in ABACUS. If they knew how smart and capable John Paulson truly was at evaluating mortgages, they are a dishonest corporation for selling any product that he deliberately calibrated to fail. At the time, they claim they believed John Paulson to be a mediocre talent. (Yeah, Right!) (Sarcasmoff.

Yet Goldman Sachs also offers a statist or a corporatist a vital opportunity. Once you’ve branded them Evil Vampire Squids, and demonstrated that they are not solicitous of the customer welfare, Government MUST INTERVENE!!!

However, this requires a fundamental mischaracterization of what a financial product is. A financial product gives the customer an opportunity to take a managed risk with their capital. An investment is like a game in Las Vegas, but with much better odds. You stand at least a 75% chance of dropping every dollar you bet on a Blackjack Table, but nobody with a functional brain claims a right to sue Caesar’s Palace because the Blackjack Table was “designed to fail.”

A car that fails to stop at red lights or a medicine that gives you a stroke instead of curing your headache is a failed product. A speculative investment is exactly that – speculative. You are playing a game. It’s not a fun game. I don’t appreciate having my retirement of my son’s college funding at stake either. As a result of the asymmetrical stakes, I play a very safe version of this game that would bore the average reader like watching paint dry on a wall.

However, investments are exactly that – a game. There’s you, and there’s counterparty that plays against you as an OPFOR. You are betting the stock will go up or the mortgages will pay off in perpetuity. That counterparty believes the stock you bought will tank or the mortgages in your MBS will go down like The Edmund Fitzgerald. If you are wrong, your wife and kid may not quite love you as much as they did the day before.

The people buying securities like ABACUS are not the average Joe with an account on E-Trade. They are institutional investors such as banks and trading houses. These people have been to college and studied Econ and Finance for lo the years. They make their decisions a wee-bit differently than I do when I shop for grapes or raisins at Publix. They tend to crunch the odds on computers that could solve a couple of hundred differential equations per second.

The most dishonest characterization being implied in this whole advantage-seeking debacle is that Goldman Sachs was somehow cold-calling widows to get them in on the ABACUS deal. Should the SEC bolster the DNC’s midterm election odds by successfully keel-hauling Goldman Sachs, they won’t protect the welfare of anyone without a PhD from The Wharton Business School or similar credentials. Unless you personally have over $100,000 in a single bank, buying ABACUS shares from GS, you are already protected by law.

So rather than getting Government to stop pressuring the banks to make stupid loans to unqualified customers for unaffordable housing, President Obama leaves off the 19th Hole for a jolly, old round of faux-populism. He picks his enemy well. No one would shed a tear over Goldman Sachs receiving a quicklime enema.

However, this case does nothing to address the fact that state-sponsored shoddy mortgages and dismal underwriting standards cratered our housing markets. It does nothing about the disingenuous rating agencies that allowed financial syndicates to introduce reams of junk MBS notes into the financial markets. The precedent that a business has to somehow predict the future and make certain that every deal will turn out perfectly for all parties or bear legal liability is terrible and an obvious job-killer.

The proper punishment for Goldman Sachs is the Sherman Anti-Trust Act. Let them be split up into various and sundry smaller, less omnipotent units. When something is too big to fail, the right course of action is to smash it with a hammer. Not even face-sucking vampire squids have an effective defense against massive amounts of kinetic energy.